Thursday, March 15, 2007

The Ides of March for mortgages

The Ides of March hath come, Julius Caesar tells the soothsayer who had told the ruler to beware the Ides of March. That's today, March 15.
Aye, but not yet gone, is the seer's answer.

What has this Shakespeare scene to do with mortgages? Well, lots.
First, there was the warning. There were lots of warnings. One of the first was from yours truly last summer, in a piece for the Norwalk Hour and its weeklies.

In essence, the experts in the story were saying that these subprime mortgages were dangerous because the borrowers could barely make their payments under the best of circumstances. Any gap in income caused by job loss or sickness, or any unexpected expense such as a car failing would throw them into a financial black hole from which they could not escape.

Many if not most of the subprime loans were variable-rate mortgages whose interest rates change every few years or even every few months. The borrowers may have thought they could renegotiate more favorable terms based on an increase in how much their homes are worth. That's not happening -- if anything, house prices are declining.

As the houses purchased by subprime borrowers go back on the market after foreclosure or surrender, and as all buyers sit on the sidelines as interest rates go up and as lenders become more selective, house prices will go lower because of supply and demand.

Is this unusual or the start of a house collapse? No, it's part of the normal cycle. It happened in the early 1990s, but that one was worse than this one will be because of the huge numbers of condominiums coming on the market 16 or 17 years ago. This cycle will work itself out as house and condo prices get low enough to entice buyers.

The first act of the drama that's playing out now. It's not over by a mile.

As my story predicted, there are many other dangerous trends that are playing themselves out that will involve prime borrowers.

Those who may be affected are people who borrowed against the equity in their homes using second mortgages, home equity loans and lines of credit to buy cars and pay down credit cards. Equity is the amount a house is worth after the mortgage and other debts are subtracted.

Interest on home loans is tax-deductible, while interest on credit card and auto debt is not. So it may make sense to borrow against the equity, as long as you can comfortably absorb the payments.

According to USA Today, 43 percent of home buyers were financing the entire cost of the home with no down payment. Many others were putting down as little 2 percent. That's not much of a cushion.

Most of these borrowers are counting on their homes increasing in value. Over the long run, it's a good bet. But if sickness or job loss enters the picture, and the mortgage is for more than the house is worth, then there's a problem.

That's what may happen to some borrowers. People who were paying only the interest on their mortgages, people who borrowed 125 percent of their home's value and others who went into negative amortization loans could be in trouble if they had to sell quickly. Negative amortization is where the debt piles up quicker that it's being paid off.

As Nick Perna, an economist who does work for Webster Bank has said, all these strategies are good if you do your homework.

But if you did not plan realistically, if you did not leave a cushion and you've gotten in over your head, then metaphorically, you may end up like Caesar. The Ides of March may have come but not yet gone for you.

1 comment:

creditandmortgageindex said...

According to USA Today, 43 percent of home buyers were financing the entire cost of the home with no down payment. Many others were putting down as little 2 percent. That's not much of a cushion.

And some still wonder why are so many people filing bankruptcy!!

No seriously, I believe the down payment should be somewhere near 10%-20% at least. 2% is nothing!

Nice article though! Would you like to reprint it on our website bad credit loans WITH your due credit of course =)